Different accounts offer different kinds of tax advantages, so it’s important to understand the mechanics of how each one works. An IRA is a great vehicle for retirement savings, because it allows an individual to invest in almost any security in a tax-advantaged way.
Traditional IRAs: Tax Savings Upfront
You can contribute up to $6,000 total into all of your traditional IRA and Roth IRA accounts annually in tax year 2022 and $7,000 if you’re 50 or older, and those limits are $500 higher in 2023. Your contributions can be deducted from your taxable income. If you were 35, making $75,000 a year, and filing single, your taxable income in 2023 would drop to $68,500 if you maxed out your contributions. Your savings could be even greater if the deduction dropped you into a lower tax bracket. Workers with high incomes might not be able to claim the full tax-deduction limit for their contributions if they’re also covered by a workplace retirement plan. These limits are calculated using your modified adjusted gross income (MAGI). Eligibility breaks down like this for tax year 2022: In addition to the tax deductions available for contributing to a traditional IRA, any gains or earnings on the investments held in the account aren’t taxed until the money is withdrawn from the account. Contributions are also finally taxed at that time. This could result in additional tax savings if the investor is in a lower tax bracket in retirement than they were at the time they made contributions.
Roth IRAs: Tax Savings in the Future
A Roth IRA is something like a traditional IRA in reverse since contributions consist of after-tax dollars, unlike with a traditional IRA. The key feature of a Roth IRA is that investment gains can be withdrawn in retirement completely tax-free. As with traditional IRAs there are income thresholds and limits that determine if and how much money you are able to contribute into a Roth IRA. Eligibility breaks down like this for tax year 2022: It can be difficult to predict what your income and tax bracket will be when you retire, so it often makes sense to put money in both types of accounts so you’ll see tax advantages either way—upfront with a traditional IRA that offers tax deductions, and on the back end with a Roth IRA that provides for tax-free withdrawals.
Get that Last-Minute Deduction
Don’t fret if it’s late in the calendar year, and you haven’t yet contributed to an IRA. You’re permitted to contribute up until Tax Day of the following year. It will still count toward the previous year. That means for the 2022 tax contributions can be made until 2023’s tax-filing deadline.
